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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to the CNA's Discussion of its 2019 Fourth Quarter Financial Results. CNA's fourth quarter earnings release, presentation and financial supplement were released this morning and are available via its website, www.cna.com.
Speaking today will be CNA’s Chairman and Chief Executive Officer, Mr. Dino Robusto, and CNA's Chief Financial Officer, Mr. James Anderson. Following their prepared remarks, we will open the lines for questions.
Today's call may include forwarding-looking statements and references to non-GAAP financial measures. Any forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the statements made during the call. Information concerning those risks is contained in the earnings release and in CNA's most recent SEC filings.
In addition, the forward-looking statements speak only as of today Monday, February the 10th, 2020. CNA expressly disclaims any obligation to update or revise any forward-looking statements made during this call. Regarding non-GAAP measures, reconciliations to the most comparable GAAP measures and other information has been provided in the financial supplement. This call is being recorded and webcast. During next week, the call may be accessed on CNA's website. If you are reading a transcript on this call, please note that the transcript may not be reviewed for accuracy. Thus it may contain transcription errors that could materially alter the intent or meaning of the statements.
With that, I will now turn the call over to CNA's Chairman and CEO, Dino Robusto.
Thank you, Margarette. Good morning, everyone. I am pleased to share our fourth quarter and full year results with you today, which reflects continued strong underwriting performance, accelerated price increases and robust growth across our U.S. operations.
Core income for the fourth quarter was $265 million or $0.97 per share, inclusive of a $48 million or $0.18 per share after-tax, non-economic charge related to our annual asbestos and environmental pollution reserve review.
I will provide more contexts to the quarter in a moment. But first, I’ll make a few comments on the full year results. P&C Underlying underwriting profit for the full year was up 15% to $362 million and the underlying combined ratio came down more than half a point to 94.8%. This is the third consecutive year of improvement in the underlying combined ratio.
We achieved 7% gross written premium growth ex captives, which strengthened as the year progressed as we leveraged the improving market conditions. Rate increases for the full year were 2.5 times higher than 2018 and increased each quarter.
New business was up 8%, as rate increases and overall improved terms and conditions led to more high-quality opportunities.
Now back to the fourth quarter results. The P&C Underlying Combined ratio was 94.9%, a significant improvement over last year’s fourth quarter results and in line with the full year 2019 results. Strong underlying performance in both Commercial and Specialty, combined with improved International performance drove the strong results.
The P&C all-in combined ratio for the fourth quarter was 95.6%, which was nearly 10 points better than the fourth quarter of 2018. Now it is fair to point out that I had categorized the 2018 fourth quarter result as an outlier and improvement in the subsequent quarters proved that out. Nevertheless, the 2019 fourth quarter result is also a full point better than the full year results.
Catastrophes in the quarter were 2.9 points or $40 million after-tax and our 2019 full year CAT impact of 2.6 points was well below the prior two years aided by the re-underwriting executed in the International property book. Prior period development in the quarter was a favorable 2.2 points.
Our expense ratio in the quarter was 33.7%, about a half point higher than our current runrate driven by some year-end true ups. As usual, James will provide more detail on our prior period developments and expense management.
Gross written premium, ex third-party captives grew 8% in the quarter, while net written premium growth was 5% in the quarter. This growth came primarily from our U.S. segment, which grew 9% on a gross basis and 6% on a net basis.
International gross written premium was up 3% as growth in Canada and Europe both fueled by strong rate increases, offset the re-underwriting actions in our Lloyds syndicate.
In the fourth quarter, we continued to achieve higher rate increases. Our P&C overall was plus 7%, up one point from the third quarter and it got better as the quarter progressed. For December, rate overall was 8%.
Commercial rate in the quarter was plus 5%, up one point from the third quarter. Specialty was plus 8%, up two points from the last quarter, and International rate was plus 13%, up three points.
In addition to greater rate achievement, we are effectively leveraging the market environment, strengthened terms and conditions and raised attachment points where needed. For example, in our aging services book, we have continued to introduce large deductibles on medical malpractice coverage, a process that began two years ago, and is starting to have a positive impact on frequency trends.
In Umbrella, we have meaningfully increased our average attachment points and we continue to reduce our limits exposure, which in the case of Umbrella were in response to the severity trends we began to see in 2018 and I discussed in detail during our last earnings call.
We believe these underwriting changes not only improve our loss exposures similar to the effective rate increases, but also results in a longer-term positive impact, as it usually takes years before market pressure reemerges to expand policy terms and conditions.
New business in the quarter grew 27% and we are right where we want to be. In that submissions are up as the transitioning P&C environment pushes more opportunities into the market, as well, we are benefiting from stronger new business pricing, which has been increasing at the same rate as our renewal pricing.
But our quote and buying ratios are down slightly in the quarter, which is appropriate as we only reach for high-quality opportunities within our target segments. We will continue to be similarly opportunistic throughout 2020.
Last quarter, I commented in detail on rate and loss cost trends and described actions we took over the last several years, both in terms of our actuarial picks and our underwriting actions in the two areas experiencing meaningful loss pressure, namely, aging services medical malpractice and portions of our Umbrella books, specifically where there are auto exposures.
Based on the reserve reviews we completed in the fourth quarter, we remain comfortable that our current accident year loss ratios and long-run loss cost trend assumptions continue to appropriately account for the loss patterns in our portfolio.
And since I remain confident that rate increases will continue running above our loss cost trends throughout 2020, I expect that, all else equal, we will see some margin improvement in the latter part of 2020 and we started off this year in good shape with respect to pricing momentum, as we achieved an additional point of overall rate increase for the month of January, compared with the fourth quarter.
And with that, I’ll now turn it over to James.
Thanks, Dino, and good morning everyone. Our Property and Casualty operations produced core income of $337 million in the fourth quarter and $1.2 billion for the full year. Pre-tax underlying underwriting profit for the fourth quarter was $87 million.
For the full year, pre-tax underlying underwriting profit was $362 million, a 15% increase over 2018. Our P&C expense ratio was 33.7% in the fourth quarter, and 33.5% for the full year. It’s worth noting that our U.S. expense ratio for the full year 2019 was 32.8%.
As we head into the New Year, we expect our 2020 P&C expense ratio to be at or below 33% as the benefit of premium growth becomes more significant on an earned basis, particularly in the latter half of the year.
Prior period loss development was favorable 2.2 points in the quarter, which reflects the outcomes of the reserve studies completed in the fourth quarter.
For the full year, prior period development was favorable 0.7 points and we remain confident in the strength of our reserve position.
Moving to each of our individual P&C business units, Specialty’s underlying combined ratio in the fourth quarter was 93.3%, an improvement of one point compared with the fourth quarter of 2018. Specialty’s overall combined ratio for the quarter was 88.2% including 4.9 points of favorable prior period developments.
This favorable development was primarily in accident years 2017 and prior, driven by professional liabilities within our Affinity segment.
For the year, Specialty’s underlying combined ratio was 93%, and the overall combined was 90.2% including 3.3 points of favorable prior period developments. Specialty’s gross written premium excluding third-party captives grew 7% in the quarter with strong rates and new business growth more than offsetting a lower retention level, which was driven by underwriting actions within healthcare.
Our Commercial segment’s underlying combined ratio was 95.4% in the quarter, which includes an underlying loss ratio of 61.4%, both substantially better than the fourth quarter of 2018.
The fourth quarter overall combined ratio for Commercial was 100.6%, including 6.5 points of catastrophe losses, primarily driven by isolated tornado events in Texas and in the Southeast, and 1.3 points of favorable prior period developments, driven by workers’ compensation, as well as property.
Commercial’s full year underwriting – excuse me – underlying combined ratio was 95.2%. The overall combined ratio for the year was 100.8%, a three-tenth improvement to 2018. Commercial’s gross written premium excluding third-party captives grew 11% in the quarter, driven by strong new business growth, increasing rates, and stable retentions.
The underlying combined ratio for our International segment was 97.7% in the fourth quarter, a significant improvement from the fourth quarter of 2018 and approximately a point better than the first three quarters of 2019. In the fourth quarter, the underlying loss ratio was 59.7%.
As we have noted in previous calls, the improvement in International will take time, but we are encouraged by the progress made in 2019. The expense ratio in the quarter deteriorated by two points year-over-year due to the reduction of earned premium from our re-underwriting efforts.
International’s all-in combined ratio in the fourth quarter was 100.3%, including 2.6 points of adverse prior period developments. Catastrophe losses were negligible. As we have mentioned previously, we have significantly reduced our international catastrophe exposure over the past 18 months and therefore we are not exposed to the international catastrophe events that occurred in the fourth quarter.
For the full year, International’s underlying combined ratio was 98.6% and the all-in combined ratio was 101.8%, a nearly five point improvement in each, compared with 2018. International’s gross written premium were 3% in the quarter driven by 13 points of rates.
Our Life & Group segment produced a core loss of $4 million in the quarter. Coming out of the unlocking in the third quarter, we’d expect to close the breakeven results going forward with some natural variability from quarter-to-quarter.
Our Corporate segment produced a core loss of $68 million in the fourth quarter. This loss was driven by our annual asbestos and environmental reserve review. The results of the review was a non-economic charge after-tax of $48 million. Following this review, we have incurred losses of $3.2 billion within the $4 billion limits that we purchased in 2010, while paid losses are now at $1.9 billion.
Pre-tax net investment income was $545 million in the quarter, a significant improvement to the prior year quarter. Our Limited Partnership and Common Equity portfolios produced pretax income of $69 million, a 3.7% return. For the full year, the LP and Common Equity portfolio generated an 11.7% return.
Pre-tax income from our fixed income portfolio was $454 million. The pre-tax effective yield on the fixed income portfolio was 4.7%. For the full year, the fixed income portfolio generated 4.8% pre-tax effective yield, slightly better than 2018.
However, given the current interest rate environment, we expect the level of performance to be difficult to maintain going forward. Fixed income assets that support our P&C liabilities had an effective duration of 4.1 years at quarter end, in line with portfolio targets. The effective duration of the fixed income assets that support our Life & Group liabilities was 8.9 years at quarter end.
Our balance sheet continues to be extremely strong. At quarter end, shareholders’ equity was $12.2 billion or $45 per share and our unrealized gain position decreased slightly to $4.1 billion. Shareholders’ equity excluding accumulated other comprehensive income was also $12.2 billion or $44.81 per share, an increase of 8% from year-end 2018, when adjusted for the $3.40 per share of dividends paid during the course of the year.
In the fourth quarter, operating cash flow was $160 million. We continue to maintain a very conservative capital structure. All of our capital adequacy and credit metrics are well above our internal targets and current ratings. And I’d be remised if I didn’t mention that CNA was upgraded by Standard & Poor’s to a financial strength rating of A-Plus during the fourth quarter.
Finally, our capital management philosophy continues to be that we will look for opportunities to invest capital back into the business as we believe we can achieve appropriate returns. Otherwise, we will return the capital to shareholders. In 2019, we returned $946 million of capital or 95% of net income to shareholders, primarily in the form of dividends.
And as we began 2020, we are pleased to announce a special dividend of $2 per share. In addition, we are raising our quarterly dividend to $0.37 per share.
With that, I’ll turn it back to Dino.
Thanks, James. Before we move to the Question-and-Answer portion of the call, let me review with some overarching thoughts in our performance. The full year underlying combined ratio of 94.8% includes for the third straight year and it is the best in a decade.
Our underlying P&C loss ratio was 60.9% for the quarter and 61% for the year. U.S. gross written premium ex captives grew 9%, while net written premium grew 6% for the year. We achieved 7 points of rates in the fourth quarter, one point higher than the third quarter.
I am encouraged by our pricing trajectory in recent quarters and based on what we have seen in January, I am optimistic that we can continue to drive rate above our long-run loss cost trends through 2020. We increased our regular quarterly dividend to $0.37 per share and we once again declared a special dividend of $2 per share.
With that, we’ll be glad to take your questions.
[Operator Instructions] We can now take our first question from Jeff Schmitt from William Blair. Please go ahead.
Hi. Good morning everyone.
Good morning.
Looking at the International book, obviously, you had a pretty good quarter. But could you give us an update on where that sort of Property book stands? Is that largely repaired? Or is there additional work that needs to be done there?
Hi Jeff, it’s Dino. What I’d say is, we are doing the right thing in International and I think it’s showing up in the results. The underlying combined ratio, as we indicated, was down 5 points and we also had lower CAT losses, which we had expected, because the Lloyds book, the syndicate was down 17% even with the strong rate increases. So, clearly, we’ve done a lot of work on that portfolio.
But there is still some work that continues and there could be some volatility quarter-for-quarter. I think what I would say is, if you think about it in terms of the premium base, I think we – you should expect the re-underwriting to probably affect our premium base for a few more quarters.
And so, there is a little bit more work to do, but a lot of it has already been done and we expect to go into 2021 with a really great – really great portfolio.
Okay. And then, thinking about the Commercial book, you had mentioned a number of times loss cost or rates in excess of loss cost trends, you plan on keeping that through 2020. And I guess, with rate accelerating, it suggests the loss cost trends are accelerating.
So, do you – as you look ahead and you think about rate, I mean, are you expecting that loss cost trends continue accelerating? And if you are going to stay out ahead that on rate, I mean, are you foreseeing a potential impact on retention if that’s the case?
Sure, Jeff. That one is good question, obviously. Look, I think, our long-run loss cost trend assumptions incorporates all that we know and we see now. So, as that evolves, we will continue to incorporate the new information. What I’d highlight is that, we have a conservative bias and how we set those loss picks and we tend to jump on bad news rather quickly.
I think our track record bears it out. If you look at our historical record of favorable development, we also – we worked really hard to react early on our underwriting actions. And then, depending on the overall market environment, to your point, we either get what we need or we’ll let retention drop, which is evidenced clearly in our aging services book and we’ve been detailing that for you over the course of the last year.
As I said, based on the quarter’s reserve reviews, we feel our picks, our long-run trend assumptions incorporate our loss patterns and we feel comfortable with the position and we’ll just keep reacting both internally actuarially, externally in underwriting actions quarter-for-quarter.
And I would just add one thing to that, Jeff. I think, just because rate is going up does not mean that loss cost trends are going up. Rate is going to be a factor of what we think we need and it’s also going to be a factor of what the market bears. And so, we are going to do exactly what Dino said with loss cost trends and we are going to continue to push hard for rates.
Okay. Thank you for the answers.
Thank you. And we can now take our next question from Gary Ransom from Dowling & Partners. Please go ahead.
Yes, good morning. I wanted to zero in on that healthcare retention of 66. I think it’s one of the lowest ones since it’s been there for a long time.
Yes.
And I know what’s – yes, you are pushing rate, you are losing customers, but it just seems like that’s – it’s a lot more significant this quarter. Can you comment on that?
Yes. I mean, it has been double-digit rate on rate. There is no question, Gary. And that’s when you start to compound double-digit rate increases, it’s a little bit more difficult. We are also being very aggressive on what it is that we need and we have been increasing it. In the fourth quarter rate was 25% and what we do is we put out the terms and conditions and if we don’t get it then the message to all the underwriters and they do know it is you let it go.
And I think, it always depends on a mix-for-mix and we’ll see if you were to go back there was some other quarters where the retention was in the low 60s, then it rebounds a little bit and it depends a little bit on the mix. But we continue to push this very aggressively and then of course, you compound that with the terms and conditions reporting larger deductibles on medical malpractice.
We pretty well doubled actually the amount of policies that now have $25,000 medical mal deductible. I mean, a few years back, the medical mal had virtually no deductibles or very, very low. So, if you put all of that together and we try to get those terms and conditions if we don’t, we’ll lose it.
And it’s going to fluctuate quarter-for-quarter. But what isn’t going to fluctuate is, our pattern of rate increases and terms and conditions. We are going to keep pushing that hard.
What’s surprising to me is, just how, I think what it says about the industry, that there is a problem that seems well established and yet others are taking it at a lower price. And I don’t know if that’s surprising to you …
Well, I mean it’s hard, yes, it’s always, Gary, you look at it across the industry and I understand that, for us, I mean, I can only tell you, we’ve been quite transparent on our healthcare, not only actions, our loss picks, our loss cost trends.
And so, we do what we think is the right thing. We think we are doing the right thing. You get it right on every deal, of course, not. And it’s difficult to say how some others may view it, in particular, when they take we let go.
All right. Thank you. And then, I am just flipping to the other extreme, where it was a small business where rates have slowed down. Can you remind us how much is workers’ comp? And what the mix is there that’s causing that?
Yes, Gary. When you look at rate, ex work comp, it’s up about two points.
Okay.
So, work comp is the largest single line in that segment.
Okay. Great. Thank you.
But it continues to grow and we got good policy retention. And so, we are happy with the – and the profitability is good. And so, we are happy with the small business.
Right. All right. And on A&E, I wanted to just ask if there was something that - I know it’s economically not – nothing to you but, you are seeing some trends beneath the surface. And I just wondered if you could give us a little more detail about what it was you saw that caused the adverse developments there?
Sure. What we saw in the quarter and really for the year was an increase in defense cost primarily, but also some indemnity costs, all unknown accounts for – as that was in environmental. So, that was really – that, in combination with reviewing our expectation for reinsurance recoverable were the two pieces that drove the change there.
Okay. And then maybe…
Maybe just to add one thing – just to add one thing to that, Gary, what we are not seeing is increase in mesothelioma plants. That trend is likely on its way down.
Okay. Helpful. And just one last question, or a broader question on the whole social inflation issue, I mean, I see your numbers. You’ve actually improved for the full year – year-over-year on an underlying basis and everyone has been talking about the social inflation and yet, you are sort of keeping up with whatever it is. And I just wonder if you have any comments on it? And anything new you are seeing in that area?
Gary, it’s clearly been a big topic for everyone. I think, it’s a trend when you start to see the trend, how you react and how conservative you are. And as I said, we don’t get it right all the time. But I do think the conservative bias has played out. I mean, I guess one comment, there is a lot of - using as a benchmark sort of attorney involvement on cases.
So, I can just tell you from our portfolio, there actually has not been a significant change and we track it by all the lines of business. We’ve actually seen slightly lower level of attorney involvement in primary auto, a little slighter uptick in primary general liability and it’s actually been flat now for several years in aging services.
And when you sort of put it all together on the third-party lines, it really hasn’t changed. So, I don’t, you know, know if that helps at all, but it’s sometimes commented on. So I just thought I’d share with you what we have in our claim patterns.
Thank you for that. That’s very helpful. That’s all I have.
[Operator Instructions] And we can now take the next question from Meyer Shields from KBW.
Great. Thanks. Two quick questions if I can. First, is it fair to assume that Affinity growth should accelerate in 2020 given what the – I’ll call it, gain/loss trends that that you are still seeing?
Meyer, I don’t think we heard that full question. Could you repeat it?
I am sorry. It sounds based on Dino’s last comments, like, overall loss trends remain under control and I am assuming that that’s true in the Affinity book, as well. Given the concerns that we are hearing from other companies there, is it fair to expect the top-line growth to pickup in Affinity because of that?
On the Affinity, as we’ve talked about, Meyer, is, these are programs, they are multi-year, they are long-term. Now we have been to write a large program, we added one large program in 2019 - but – 2018 actually, which played out throughout the quarters of 2019 – all four of the quarters actually, which makes some of the growth comparison on Specialty seamless, because of this program.
But, you don’t write those every quarter, right? There – we go after them. We clearly have an expertise over the last several decades. We are always looking for them. But it’s got a fit. It’s got to be the right type of program at the right profitability in all of this component parts.
So they are harder to combine. But clearly, we have a team that’s always focused on it. And we’ll keep our eyes open to continue to grow it, because it is very profitable for us.
Okay. Thank you. Second question, I just want to make sure I understood your response to Jeff. It sounded like there is still some works coming in the International segment. But in the fourth quarter, I guess, it looks like the upside of rate outpaced the exposure reduction. Is that a fair expectation for 2020?
I think, what Dino’s comments were primarily around the Lloyds portfolio. Remember, we also have a Canadian business, which is not undergoing the kind of re-underwriting that’s happening in London. And that’s growing quite nicely, as well as the continental business is actually growing, as well, based on significant rates that they are getting there. So, you have really two of the three components to that International business are growing more organically and offsetting what’s happening in the Lloyds portfolio.
Okay. Understood. Thanks so much.
[Operator Instructions] There are no further questions on the line at this time. I would now like to turn the call back to the hosts for any additional or closing remarks.
No, that’s great. Thank you and we’ll chat next quarter.
Thank you. That does conclude today's conference. Thank you for your participation, ladies and gentlemen. You may now disconnect.